There is a great deal of discussion about solving the current financial crisis by nationalizing the major money center banks, such as Citigroup and Bank of America. Every time this suggestion surfaces, Treasury Secretary Geithner issues a statement emphasizing that the Obama administration is committed to avoiding this outcome and keeping banks in private hands. We are now seeing discussions about an increase of the government's equity investment in Citigroup (NYSE: C).
Why is there such fear of bank nationalization? Some claim that this would mean the death of capitalism and the rise of socialism. However, this solution is being discussed by both Republicans and Democrats. In addition, no one expects the government takeover of the banks to be permanent like France, which eventually did take the banks private again. This would be only temporary in nature as during the Swedish banking crisis.
Others claim that this would be unprecedented and a step past the point of no return to a socialist economy. However, the government undertook similar action with the Savings and Loans and the formation of the Resolution Trust Corporation (RTC) in the early 1990s. In addition, during the mid 1980s under the Reagan administration, the FDIC effectively nationalized Continental Illinois, then the seventh largest bank in the country. It was eventually sold several years later.
The Gipper was called many things, but a socialist was never one of them. If he could do it, why can't we do it today? The answer lies in what we mean by nationalization? In the case of Continental Illinois and the Swedish banks, the shareholders were wiped out, and the creditors, including the bondholders, were made whole.
Bailing out the bondholders of these banks is a very expensive proposition. It can also create an entire new set of FreePassers, who purchased the bonds at steep discounts and could make a fortune under such a nationalization scenario, leaving the U.S. taxpayers to foot the bill.
However, we saw what happened with Lehman Brothers when the bondholders were penalized. There may possibly be substantial amounts of these bank bonds held by central banks and sovereign wealth funds, which may also own quite a bit of U.S. government debt. They might not be very happy writing down the value of their holdings. In addition, no one is really sure what the underlying toxic bank assets are worth.
The government has to address these issues in formal bank nationalization but can dance around the situation as it injects capital into these banks and takes larger and larger equity stakes in these institutions without really addressing the underlying solvency.
Thus, the current game of cat and mouse continues. The banks pretend to be solvent while asking for money for a "temporary liquidity" problem. The government pretends not to nationalize them as they give them money in return for larger and larger equity stakes.
Doug Roberts is the Founder and Chief Investment Strategist for ChannelCapitalResearch.com. He is the author of Follow the Fed® to Investment Success. He previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.